Effectively Managing a Food Safety Product Recall

RGL Partner Simon Oddy addresses the complexities associated with the ever-growing global food chain in the June 2013 issue of Litigation Management.

When horse meat DNA was found this year in products sold as beef across multiple countries, the incident impacted many companies with otherwise stellar reputations and underscored the complexities of our global food supply. Products used on a daily basis have longer, more complex supply chains, with ingredients coming from an increasing number of geographical sources that may have different regulations for processing, labeling and handling food.

With food product recalls on the rise, more companies are wisely investing in product contamination and product recall insurance. Yet, in these complex supply chains, the potential for disputes and litigation regarding insurance claims is also increasing. The interaction of insurance policies and the levels of coverage can lead to complications in measuring the recoverable loss and understanding the interplay between product contamination, product recall and product liability.

Multiple Parties

Imagine this scenario: A small U.S. business (Company A) imports a spice from Mexico and sells it to Company B, which adds ingredients before selling its flavoring product in turn to a multinational food processor and distributor (Company C) that uses the flavoring in its flagship product— a food dressing.

An outbreak emerges when state health departments begin receiving reports of consumer illnesses. The CDC and FDA are notified and investigators identify Company C’s dressing as the likely source and further trace Company A’s spice as the cause of contamination. As crisis management protocols engage, Company C isolates and recalls the relevant batches of spice, yet media coverage escalates as illnesses increase. Company C finds itself at the heart of a swirling crisis, having to respond to concerned and angry retailers and consumers.

In the aftermath, Company C and Company B file claims against Company A totaling $2.5 million alleging financial damages from the use of A’s spice. The claims include lost profits, loss associated with future product launches due to consumer concerns, shipping, brand reputation and other losses from the recalled product. Fortunately, Company A is covered for product liability and dedicated product recall coverage and ultimately submits a claim to its insurance company for its own losses, as well as those of its customers. However, before any claim is paid, an investigation, review and due diligence process must occur. This will involve insurance adjusters, relevant experts, forensic accountants, and other resources. Herein lays the key – documenting the cause of the alleged contamination, its impact and the resulting losses.

Companies B and C will be understandably impatient to receive payment for their damages while Company A will look to preserve the business relationship with B and C. It will also seek to recover any payments it makes to B and C in settlement of their claims, while documenting its own direct losses. To increase the chances of a mutually acceptable settlement Company A engages its customers early in this review process so that the third party claims can be supported and documented before crucial evidence is lost, damaged or deteriorates. The review will need to consider the claim support available for losses suffered by A, B and C.

Company A’s actions will be critical to ensure that cooperation from B and C is feasible even if there are differences between B and C’s view of the financial impact of the loss and their demands of A addressed by the insurance companies. This difference might be referred to as an expectations gap and relates to uninsured losses.

Managing the Expectations Gap

Disconnects and assumptions from one or all parties emerge at various stages of a contamination event and can significantly impact how claims are resolved. Practical experience has shown that expectations gaps can best be managed early in the process. Such gaps may exist when one or all parties believe that:

Crisis management insurers should make claim payments immediately based on a gut-feel estimate or on limited loss investigation.

The required information and document review could be performed after initial payments are made or can be undertaken remotely

The insurance policy will cover all financial losses for the Insured and its customers without consideration of cause and effect.

Expenses incurred and allocated to dealing with the problem that are normal operating costs should become part of a claim.

One policy will cover all losses associated with a product recall.

Unaffected/uncontaminated production batches that are returned by customers or held in inventory should automatically be considered contaminated.

Indirect overheads are included in the inventory valuation or costs avoided are not considered in the loss of gross profit calculations.

Overall sales trends for the Insured’s product portfolio are not considered.

Anticipating these disconnects for what they are and mitigating them through effective communication can help all parties navigate a food recall and related insurance claims more efficiently.

Navigating Key Decisions

Company A has a number of decisions in order to manage the tension created with its customers. It must set clear expectations, reassuring its customers that their claim will be addressed, but it will need to obtain supporting documentation for the amounts claimed by its customers. If a gap caused by uninsured losses exists between Company A’s coverage and the settlements being claimed by its customers, A must decide whether it will pay the difference above what is not covered by insurance, and how best to manage the business relationships with customers, recognizing the litigation risk, if they are dissatisfied with the settlement amounts.

These options may be limited by the leverage that exists between the companies. Company B or C may be a dominant player, leaving Company A with fewer options. The degree of cooperation and documentation, or lack thereof, from B and C can be critical in the claim review by Company A’s insurer, affecting whether the resolution is timely and amicable.

The company’s systems should enable a robust traceability exercise such that Company A and its customers can demonstrate the extent to which contaminated product actually made it into the claimed finished products. Where possible, only the specifically contaminated product should be accepted as returns, and related costs should be recorded accordingly.

Measuring the Loss

The insurer’s goal in managing the claim review is to develop an accurate evaluation of the recoverable loss. Among the first steps insurance adjusters take (frequently with the assistance of forensic accountants) is to analyze the claim against each potentially invoked policy and to segregate costs to the appropriate policies and cover afforded by each.

The adjusters’ work will include establishing the recall population and then testing a representative sample of the potentially affected products in order to determine the extent of contamination, if such exists. The quantum assessment, subject to cover being triggered, will include an assessment of incurred and future costs as well as business interruption impact. Forensic accountants will quantify the cost of handling and disposal of the recalled product, product replacement and clean-up. The two will work together to value the more subjective aspects of a claim, such as lost profits and lost market share—calculating losses in context of broader market forces, sales prior to the recall, and product replacement (i.e., increased substitute product sales offsetting losses from the recalled product).

When Litigation Occurs

If litigation is unavoidable, forensic data is essential in strengthening the case for all parties:

Supported financial claims – Analysis is essential in supporting aspects of a recall where factual data is available regarding the financial measurement of the loss.

Subjective financial claims – Forensics uses loss measurement techniques recognized by the judicial system to estimate subjective losses such as loss of gross profit or erosion of brand reputation, where external market factors impact the numbers. The insurance contract will provide definitions on appropriate measurement for recoverable loss.

Product recall litigation is not limited to food safety—similar challenges are involved in automotive recalls, toys, consumer goods, construction materials and medical devices. In class action instances, the data is more complex because settlements often involve financial modeling to project a total picture of future as well as current impact.

Broadened Coverage

Generally the trigger attribute for a covered event has been proof of accidental contamination, impairment or mislabeling, where a product caused or can cause illness or death. However, broader coverage-triggers in some newer policies allow for certain “softer” precursors to proof of contamination, such as:

Has a company been recommended or requested by a governmental agency to conduct a Class I or II recall.

Has media coverage implied or alleged that the company is involved in an accidental contamination event.

Experience and data suggest that these additional triggers create the same crisis management requirements, loss of business, damages, liabilities and reputation issues as an actual accidental contamination event.

Under product contamination or product recall specialty policies, insurers cover the engagement of crisis management experts—legal, PR, food science and others—to help companies navigate the many aspects of a food recall. These experts operate under NDAs given the sensitive data involved. Due to their experience, they also bring best practices to the time-sensitive situation.

Best Practices

Given the high stakes in a product recall it is essential to have a protocol for such a crisis in place prior to an event. For Company A, the source of the recall in our hypothetical scenario, following a few best practices can help minimize damage to its business relationships and financial position and help to avoid litigation:

Create an atmosphere of productive communication with insurers, customers and other parties to promote a smooth process.

Engage the customers early in the process and encourage their participation in the claim review.

Provide the adjuster and team with access to data for segregation, measurement and support of the losses.

Be prepared to manage cash flow issues during the affected period.

Have a crisis management plan in place before an event occurs to enable quick, strategic responses that may help resolve a recall incident effectively.

Given the complexities of our global supply chain it is almost inevitable that contamination issues will occur. Enhancing capabilities for managing such a crisis with improved operations processes and better traceability improves a company’s ability to support losses during the claims process. The insurance company is motivated to partner with its policyholder so that it survives the crisis event. This will enable the Insured to get back to business as expeditiously as possible.

Simon Oddy, ACA, CFE, MCIArb is a Partner in the New York office of RGL Forensics. David Perry, ACII, PCA is the Director and Executive Vice President in the Miami Office of Charles Taylor Adjusting. Joseph F. Bermudez is the regional managing partner of Wilson Elser in Denver.